Terror threats and the Eurozone recovery

Following the Paris terror attacks, equities traditionally sold off across the board, as per the norm following such events, with an influx seen into safe haven bonds. The move was one of panic however and was short lived as equity markets, including the CAC 40 were quick to recover losses. The question remains though whether political tensions arising as a result of these attacks will affect the Eurozone recovery.

Mario Draghi came out last week reinstating that the ECB were ready to do what it takes to get inflation back on track. This is no doubt a strong signal that further QE is expected to be rolled out in December, with equities at the forefront to benefit. The tourism industry may have been dealt with a setback on the other hand as airlines notably face a potential hit to 4th quarter revenues for 2015. With airline equities recovering post-attack losses last week, mounting global terrorism threats over recent weeks may push many fearful travelers to reconsider booking their Christmas holiday getaways. The retail sector could also be affected as fearful customers stay off the streets, pushing off their Christmas shopping.

Although a transitionary phase, tighter border controls implemented across the EU could linger on for a while as the Schengen area faces increased pressure to beef up its border checkpoints. The consequence may negatively impact manufacturing companies for one, heavily reliant on cross border trading activities.

Should terrorism threats persevere, political risks may also present themselves with a potential increase in popularity of far right political movements, namely the anti EU, anti-immigration Front National party in France led by Marine Le Pen.

French government bonds, meanwhile, may also see downside risk as the French government readies to increase expenditure on added security measures. Should a successful coalition be formed to further intervene in Syria, France could see its defense budget soar and its fiscal deficit widen.

One may argue that in theory, European investors should have sold off on equity positions and increased allocation to investment grade fixed income securities, given the above risk factors, but with markets having already recovered post attack losses and the ECB firmly adamant to boost inflation, investor sentiment remains assertive to yield and confident on an eventual gradual Eurozone recovery.

With the French economy a main driver behind Eurozone growth, investors will have to keep a close watch on French CPI figures, as the latest data came out a mere 0.1% higher year on year. A radical improvement is needed if inflation targets are to be met.

Should consumer confidence see past the current round of terrorism threats and political tensions, any reforms undertaken by the French government or any EU member for that matter as a result of these threats should imperatively not undermine the objectives of the ECB.